Employee stock ownership plans (ESOPs) have been on the corporate landscape for over four decades. In their early history, ESOPs typically acquired a minority ownership interest in the stock of the sponsoring private or public company. In non-public companies, where the stock was acquired in a party-in-interest purchase transaction, typically from the founder or founder’s family, that stock ownership was generally in the range of 30 to 49 percent of the company’s outstanding equity. The non-ESOP shareholders retained the controlling interest. In this scenario, ESOP trustees found some comfort in the fact that non-ESOP shareholders retained a significant ownership stake in the corporation. Typically, the non-ESOP shareholders were the founders, family, board of directors, and/or managers of the business.
With the passage of time, second and third-stage ownership transactions evolved with some ESOP’s ownership reaching 51 percent of the company equity, thereby becoming a control shareholder. Change also began appearing in corporate governance of ESOP companies such as the structure of the board of directors to include outside independent directors selected based on a candidate’s skills and experience.
In 1998, the S corporation ESOP created the economic incentive and financing viability for a leveraged ESOP to own virtually all of the employer corporation stock.
This article will not provide an explanation of the economics of S corporation ESOPs. That subject has been amply covered in the professional literature. Rather, the focus of this article is about the phenomenon of ESOPs becoming the controlling or the sole stockholder of the sponsoring company, including the fiduciary and corporate governance implications of such.
Trustees of 100% ESOPs need to consider their duties regarding the ESOP’s ownership control position. In addition, in a 100% ESOP company, employee trustees are placed in an increasingly difficult circumstance of managing the inherent conflict of interest between their employee status and their ERISA fiduciary duty to act in the exclusive best interest of the trust.